With rig rates dramatically reduced due to the fall in drilling activity during the financial crisis and given improvements in drilling efficiency and completion techniques, US tight and shale gas reserves can now break even at gas prices as low as $3/mmbtu (from between $4.50-8/mmbtu but 3 years ago). This means that many projects are competitive with both conventional piped gas and with LNG imports. Moreover, given the ready supply of gas and the strong likelihood that production volumes are set to significantly increase in the future, it is likely that unconventional gas will set the marginal price of gas in the US for the foreseeable future.

The same cannot be said however for the rest of the world where exorbitant drilling costs require a gas price nearer $7-10/mmbtu. While drilling costs have fallen considerably in the US (for example average well costs in the Barnett have fallen from near $7-8mln per well in the 1980's to today's $2-3mln per well) we cannot extrapolate this performance to the rest of the world, particularly Europe where it currently costs between $20-25mln to drill a single well. Not only are the plays geologically more challenging, but Europe also has a number of other impediments such as limited supply of key services, lack of necessary infrastructure, language barriers and stricter environmental regulation and land access rights (Europe is geographically smaller and more built up vs. the location of unconventional gas reserves in the US). Below we present Wood Mackenzie's most recent assessment of well costs and break even gas prices around the world. This highlights the challenging economics of developing unconventional gas plays outside the US in most other regions.

Despite the high costs involved, large industry players continue to commit both financial and human capital towards evaluating the potential of international unconventional gas assets. Recent licensing rounds in Romania and Poland saw a significant up-tick in the level of companies tendering for acreage, with the focus being on those areas which are believed to contain significant gas reserves. We expect increased investment in the evaluation of these resources over the coming years.

Environmental pros and cons
Finally, as with CBM there are a number of environmental considerations with tight/shale gas. While gas is environmentally cleaner to burn than oil, there are concerns over the impact current extraction techniques (in particular fraccing) could have on the surrounding environment. The main concerns include the mishandling of solid toxic waste, a deterioration in air quality, the contamination of ground water from use of chemicals and the migration of gases and hydraulic fracturing chemical to the surface. The US Energy Policy Act of 2005 exempted hydraulic fracturing from regulation under the Safe Drinking Water Act. However, the FRAC Act 2009 (not yet legislation) makes calls for the practice to be regulated and for energy companies to disclose what chemicals they are using in the fraccing process.

Eoin Treacy's view Natural gas is one of only a handful of commodities that have failed to rally over the last year. We have described the advent of shale gas as a game changer for considerable period and the increased supply of the commodity at a time when the US economy is still only beginning to recover has contributed to depressed pricing.

Natural gas is a clean burning, relatively low carbon fuel and offers the ideal intermediate solution to the global energy sector at least until alternatives have developed to an extent that they are economically competitive. This is predicated on niggling environmental concerns relating to hydraulic fracturing and ground water contamination being ironed out.

Natural gas prices have been ranging below $4 since late August but need to sustain a move above that level to indicate a relief rally is getting underway. A sustained move above $6 would be needed to suggest demand is regaining medium-term dominance.